By Balazs Koranyi, Francesco Canepa and Frank Siebelt
FRANKFURT (Reuters) – The European Central Bank can buy just over one year’s worth of German bonds under its new asset-purchase program and must bend its own rules to keep the scheme running longer, risking fresh internal and legal conflict, two sources familiar with the process said.
Facing weak growth and low inflation, the ECB decided last month to start buying debt indefinitely. That opened a rift in a normally collegial Governing Council — conservative policymakers felt they had been strong-armed into a scheme that will be difficult to manage and exit.
Opponents of the purchases — the central bank chiefs of the euro zone’s biggest countries, France and Germany, among others — argued that the purchases should have been an emergency tool. Indefinite buying could conflict with the safeguards the ECB set up to keep it legal, they said.
Those safeguards include buying no more one third of each country’s debt and buying bonds according to each country’s shareholding in the ECB, commonly known as the capital key.
But if both rules are strictly followed, just over one year’s worth of eligible German bonds are left on the market, the sources said. That will force the new ECB president, Christine Lagarde, to solve a difficult problem created by her predecessor.
To delay hitting this wall, policymakers would prefer “bending” the capital key and buying fewer German bonds rather than changing the issuer limit, two other sources, with direct knowledge said.
The ECB has already deviated from the capital key in the past. By sticking to this practice, the ECB could buy German bonds “beyond a year,” a fifth source, familiar the ECB’s decision-making, said.
An ECB spokesman declined to comment.
Deviating from the capital key does not have direct legal implications, so it would be easier to defend in a court of law, where the program has already been challenged by a group of German academics. But it could be politically risky, since it would put Germany, the biggest opponent of the program, at a disadvantage.
Still, it would take time for any divergence to become significant, and the ECB can argue that past purchases also deviated as the bank sucked up extra debt in Italy, Spain and France to make up for countries where it could not buy.
The ECB’s holdings of Italian, Spanish and French debt are currently 8.4%, 7.4% and 3.9% above their quotas, according to Reuters calculations, which exclude Greece because it is not eligible for purchases.
The problem is that the share of German debt is already 1.3% percent behind the capital key, an argument for some that the ECB is bankrolling profligate countries at the expense of virtuous Germany.
But the capital key is supposed to apply to the stock of government bonds, now totaling 2.1 trillion euros on the ECB’s balance sheet.
So it will take time for the new government bond purchases, which are likely to be in the region of 15 billion euros a month if history is anything to go by, to affect the total in a material way.
The European Court of Justice has already cleared the bond purchases, dismissing a challenge by the German academics. But it said that safeguards, such as the ECB’s self-imposed rules, are necessary to ensure the bank does not finance governments, a major taboo under European law.
Changing the issuer limit could fuel a fresh legal challenge, and the ECB’s legal committee has already highlighted this risk, the Financial Times reported earlier.
Indeed, the German complainants, headed by the Berlin professor Markus Kerber, also indicated that the new bond purchase change the nature of the program, so courts should have a fresh look.
Another option the ECB could consider would be to buy more private-sector debt to rely less on government bonds, but three of the sources said there was little appetite for this.
The ECB has already been burnt on the bonds of scandal-hit South African retailer Steinhoff in earlier purchases. Many in the Governing Council argue that a bigger presence in the private-sector market would unduly lower risk perception.
Still, any method to prolong German purchases only buys the ECB a limited amount of time before the issuer limit is reached. Lagarde will have just months to solve this, the sources said.
A solution is also pressing because the ECB pledged bond purchases until just before it starts raising interest rates. Markets don’t expect that until 2025, well after it will hit its limits in every country.
(Editing by Larry King)